German chemist Otto Bayer did not know what to do with polyurethane foam when he invented it in 1937. Today the chemical is omnipresent in household appliances and cars, and is at the heart of Abu Dhabi state oil group Adnoc’s effort to seal Europe’s biggest takeover deal this year.
The target company, Covestro, is a jewel of German industry. Spun out of pharmaceuticals-to-chemicals conglomerate Bayer in 2015, its Leverkusen headquarters sit in the industrial heartland of North Rhine-Westphalia — a state brimming with potential customers for its products.
But times are not as good as they once were. High energy prices and sluggish consumer demand have hit Germany’s manufacturers, and their suppliers, including Covestro, are feeling the squeeze.
“Europe is getting less and less competitive, especially Germany,” chief executive Markus Steilemann told the Financial Times at Covestro’s most recent earnings, when the company narrowed its full-year profit outlook.
The chemicals industry lobby group that Steilemann chairs has warned that Europe’s largest economy is deindustrialising and urgently needs support.
The call was heard by Adnoc, which pumps almost three times as much crude oil every day as Shell and has built a 50-strong team of dealmakers headed by former Morgan Stanley executive Klaus Froehlich to scour the world for acquisitions, especially in gas and petrochemicals.
The two sides have been in talks for more than a year as Covestro rebuffed a series of lower offers and have completed due diligence, with Adnoc expected to make a formal offer of about €14.4bn including debt.
Sultan Al Jaber, the Abu Dhabi group’s chief executive, was in Germany in the last week of August to finalise negotiations, according to two people familiar with the matter.
If the deal is accepted, it will be one of the largest cash transactions ever in the chemical sector and the first time a Dax 40 company has been bought by a Gulf state.
“This is the old Bayer material sciences business which is one of the few companies globally that have basically invented chemistry,” said one person working on the deal.
“Bayer took a different direction and spun it out and since then it was on its own in a very cyclical industry,” they added.
Covestro’s three most important products, all of which it invented, are two types of chemicals, MDI and TDI, which are used to make different forms of polyurethane foam, and polycarbonate, the strong but transparent plastic that was popularised in CDs and DVDs but is now more commonly used for car headlights, sunroofs and electric vehicle interiors.
Many of Covestro’s chemicals are petroleum-based, but the German company is experimenting with using plant and waste alternatives, and with recycling.
“MDI is used for rigid foam, which is predominantly an insulation material. If you cut open a fridge, you’ll see rigid foam, and that’s MDI,” said Sebastian Satz, an analyst at Citi who covers Covestro.
“It is a relatively consolidated industry with just a handful of global suppliers, and it is difficult to enter because it is complex chemistry and building a new world-scale plant would cost you probably close to €2bn.”
“TDI is used for soft foam. You may be sitting on it as we speak and it is used for car seats, cushions and mattresses,” he added, noting that the market for TDI had been saturated by Chinese competition.
The person working on the deal said Covestro’s specialisation in foams placed it squarely in the middle of an energy transition megatrend, as countries bring in more regulations around insulation and energy efficiency.
Its polycarbonate business, meanwhile, will benefit as electric-vehicle makers seek to replace metals with lightweight but strong plastics.
Foreign takeovers of German companies, such as the 2016 purchase of industrial robotics group Kuka by Chinese appliance maker Midea, and US-based Carrier‘s acquisition last year of family-owned Viessmann’s heat pump business, have sparked concern in Berlin about the fate of the country’s industrial edge.
But the attempted takeover of one of Germany’s most innovative chemical groups by a state-owned Gulf company has barely raised any discussion among politicians.
The federal ministry of economic affairs said it could not comment on “business decisions or negotiations between companies” or on “hypothetical considerations regarding investment reviews”.
The economics ministry for the state of North Rhine-Westphalia told the FT that it was “closely” following the negotiations, but said the “interest in taking over Covestro shows that the company’s future prospects are viewed positively”.
Satz said the plastic industry was “probably not seen as strategically important” by Berlin.
“I don’t really anticipate that there would be any issues, not on antitrust because they do not really have an overlap, but also not with regards to the German foreign investment policy,” he said.
“Also because they might put more money into the company it should not have a negative impact on employment in Germany, so we would not expect any material pushback on the side of the unions, either.”
Satz estimated that the MDI market would continue to grow at about 5 per cent a year, with TDI growing at 3 per cent.
“Covestro has a leading position, with assets at the bottom of the cost curve and in all of the key regions: Europe, Asia and the Americas. That has allowed them to always generate a positive free cash flow going back as far as we have data,” he said.
He calculated that the cost of building Covestro’s facilities from scratch would be more than €90 a share, well above the €62 a share that Adnoc is likely to bid.
“If anyone wants to enter those product chains organically it is not only very risky, but also much more expensive. So you can come in and buy the market leader with great assets at a significant discount and still make shareholders happy because you are paying a premium,” he said.
Christian Faitz, an analyst at Kepler Cheuvreux, said Covestro was a “perfect fit” with Adnoc’s ambition to tap into sustainable technology, as the company’s foams and chemicals were “key enablers to making buildings more energy efficient [and] cars more lightweight”.
But more importantly, a successful deal would offer Adnoc access to a global set-up — its 17,500 employees are spread across Europe, the US and Asia, with less than a third of production based in Germany — and “a perfect customer list”.
Covestro’s shares have not traded above Adnoc’s likely bid price in the past six years, a period when the chemicals industry suffered from boom and bust cycles as competitors brought huge new plants online and slashed prices to win orders.
The company’s ebitda last year was less than a third of what it earned in 2021, and analysts at TD Cowen believe Adnoc’s indicative bid represents a roughly 50 per cent premium to the undisturbed share price.
“They had great years but they also had years where suddenly earnings are much smaller, which means you have to tighten the belt a little bit, which means, even if you want to grow, you might have to postpone projects when you are listed compared to when you are not listed,” said the person close to the deal.
“If you are in a cyclical industry you have to always pre-empt the next cycle and not by accident overextend yourself with the next €2bn project.”
Having access to Adnoc’s resources, with the company pledging to spend $150bn between 2023 and 2027 on capital expenditure, would be the main advantage of the deal for Covestro, according to Satz.
Faitz also said Covestro, with its cyclical business, could benefit from having an owner with “a long-term plan to developing assets, which would give it security to make long-term decisions and not be criticised every single quarter by analysts for bad numbers”.